Question

What is the relationship between the global financial crisis and these large swings in the value of dollar?

Answer 1

During financial crises, capital typically flees the crisis country and moves into safe haven currencies, namely the yen, the Swiss franc and the US dollar. During the most recent crisis, however, safe haven effects led to capital flows into some of the countries most affected by the crisis. Therefore, it may not be surprising that these flows reversed as soon as risk aversion abated, with a corresponding reversal of exchange rate movements. Comparing the latest crisis with two earlier crisis episodes, we find that the role of short-term interest rate differentials in both the depreciations and their reversal has grown over time, perhaps reflecting the increasing role carry trades play in exchange rate movements. This factor may have changed the dynamics of exchange rates around crises more generally, affecting a broader set of currencies and leading to more pronounced swings in exchange rates during and after crisis episodes.